China growth concerns pushing markets sharply lower

Concerns about Chinese growth prospects and a possible rate hike by the Federal Reserve are creating worries and helped push equity markets sharply lower on Monday.

Last week saw stock market prices tumble and the declines accelerated on Monday. Last week’s decline was triggered in part by the Chinese government’s decision to devalue the Chinese yuan in several steps. Investors interpreted this as meaning the Chinese government is worried about a sharp deceleration in economic growth and therefore must devalue the currency and implement supportive measures to bolster a fragile situation.

Meanwhile investors are fretting about a possible rate hike by the U.S. central bank in September or December.

“Signs of weakness from China alongside concerns about the effects of a Fed interest rate hike have caused investors to adjust their growth forecasts downward and modify their views on how much investment risk is appropriate,” writes Fredrik Öberg, SEB’s Chief Investment Officer in note to customers.

In recent years, global economic growth has proceeded at a leisurely pace. Record-low interest rates and large stimulus packages have not led to the rate of growth that people had hoped for. However, the economic system has stabilised and adjusted the valuations (prices) of financial assets upward as well. In a situation like this, there is a risk that the global growth rate, which in turn is an important variable in explaining the business sector’s ability to generate increased earnings, will not move in step with financial asset prices. When uncertainty factors surface, the result is profit-taking and lower risk appetite.

“The markets are probably now adjusting from a period of extremely low volatility (small price swings) to a more normal environment, and this also affects investors’ views of what are appropriate prices for equities, corporate credits and other assets,” Öberg says.

He says that the economies of regions and countries around the world continue to move in different directions, and the overall rate of growth is less than we had hoped. Still, growth has not come to a halt. It is most likely that we are now experiencing a market correction and not the beginning of a sustained decline.